Confidence Game - Christine Richard [132]
Problems began to appear in other parts of the auction-rate market. Frances Constable, the head of Merrill Lynch’s auction-rate desk, wrote to colleagues in an e-mail on August 9: “Markets are shutting down bit by bit. We have [five] failed auctions so far, with three more likely today.”
Three days later, another Merrill employee sent around an e-mail saying he’d been in contact with “John and Fred” at MBIA. “They are obviously concerned about a failed auction and the ramifications thereof.” The employee added, “They see a program failure as having potential franchise ramifications.”
On August 16, a colleague sent Constable on the auction-rate desk a copy of a Fitch Ratings report discussing the implications of failed auctions for bond insurers’ securities. Constable did not need to be reminded of what was happening in the ARS market: “Come on down and visit us in the vomitorium!! We will be sure to provide it to all those holders who, according to the article, are likely to get caught up in this latest round of likely fails.”
Over at Lehman Brothers, things weren’t any better. On August 21, an adviser to the Maher brothers e-mailed Lehman to say he was concerned about the allocation of their money. After receiving the e-mail, Lehman attempted to liquidate all the securities but failed.
Ominously, the banks did not step in to show support for the bond insurers. “The auction product does not work, and we need to use our leverage to force the issuers to confront this problem,” Ross Jackman, who oversaw the short-term securities trading desk, e-mailed David Shulman, global head of municipal securities group at UBS, on December 12.
Three days later, Shulman e-mailed Joseph Scoby, UBS Securities’ chief risk officer, asking for guidance on whether the firm could continue to support auctions. The problem with pulling out of the market, Shulman noted, was that retail investors had been told these securities would “be redeemed at par on demand. Although there is no formal liquidity provision in place.”
Merrill Lynch was fielding a steady stream of questions from investors and issuers worried about the auction-rate market. On November 30, Constable e-mailed colleagues telling them that any negative news about the bond insurers was leading to a further collapse in confidence.
Two days earlier, on November 28, Bill Ackman had taken the stage at the Value Investing Congress, telling the audience he expected to make hundreds of millions of dollars on the collapse of the companies that were holding together the auction-rate market.
The banks were fighting a losing battle. “The recurring conversation here on the auction-rate desk is a line out of Marathon Man,” Constable continued in her e-mail. That line was the one made famous by Laurence Olivier as he subjected Dustin Hoffman to torture dentistry while calmly asking a question for which Hoffman had no answer: “Is it safe?”
Wall Street firms continued to insist publicly that it was, but privately the concerns were mounting. “If you find yourself experiencing a horrible auction—that is, you need to support more than 25 percent … call risk control before you support it,” Scoby over at UBS cautioned in an e-mail to Shulman a few days before Christmas. “If you see signs that other dealers are walking away from auctions, let us know.”
Two days later, Christopher Long, who managed UBS’s short-term securities desk, sent an e-mail to Shulman and others laying out his worst fear: “Monoline insurance providers are downgraded multiple notches and the demand for [auction-rate securities] retracts exponentially.” He had good reason to be concerned. UBS’s inventory of auction-rate securities was ballooning as the firm continued to support the market.